Balance of Payments .

1. Balance ofPayments. Global imbalances and how they occur. Theory and evidence from reality

2. Balance of payments. – Global imbalances Today‘stopics Balance of payments; definitions Current Account and Capital account; definitions Imbalances of the partial balances Savings as determinant Types of foreign investment Case analysis: USA Dipl.- Kfm. Thomas Stiegler, University of Göttingen.

3. Balance of payments. – Global imbalances Balance ofpayments – whatisit? consists of two under balances: Current Account and Capital account is qua definition always balanced illustrates how real economic activity is backed by financial activity In reality imbalances can occur. The so called “remainder” is due to problems in accounting Dipl.- Kfm. Thomas Stiegler, University of Göttingen.

4. Balance of payments. – Global imbalances Imbalances IN the Balance ofpayments? Global imbalances if the balance of payments is always balanced? Balance of payment can show clearly the competitiveness of an economy and the results on the ownership of the stakes in this economy. it allows conclusions about the sustainability of the behavior of the economic subjects (people) in an economy All this we can see in having a look at the two under balances Dipl.- Kfm. Thomas Stiegler, University of Göttingen

5. Balance of payments. – Global imbalances The currentaccount - definition the current account shows the real economic balances of a country with its foreign trade partners it consists of: foreign trade balance: goods traded between an economy and abroad services account: services traded between an economy and abroad balance of factor incomes: paid and received return on international investments, earnings from international work transfer balance: transfers to/from a country without being backed by any economical activity (we won’t focus on this part further, as it is raher influenced by migrational issues than by economic ones) Dipl.- Kfm. Thomas Stiegler, University of Göttingen

6. Balance of payments. – Global imbalances The capitalaccount - definition the capital account shows the financial, monetary transactions between a country and abroad. It consists of: Foreign direct investment: investments in production facilities as 1) investment in existing firms or 2) greenflield investments balance of credits given and taken portfolio investment: investments in shares and bonds. change in Central Bank’s currency reserves Dipl.- Kfm. Thomas Stiegler, University of Göttingen

7. Balance of payments. – Global imbalances Real vs. Financial transaction Balance of payments: balanced.  Current account equals capital account. Why is that? we sell a product to the US (real economic transaction) we accept US Dollar (financial transaction) Dipl.- Kfm. Thomas Stiegler, University of Göttingen

8. Balance of payments. – Global imbalances Recievingforeigncurrency – a basicfinancialtransaction (1) Let’s have a look at the last point again, as it is not intuitive: If you go to a shop in Russia, you can’t pay anything with a Dollar bill. The US Dollar is NO MONEY in economical definition in Russia (no accounting unit, no mean of exchange) However the firm selling its goods to the US accepts a payment in Dollars. A one Dollar bill is a promise of payment of the Federal Reserve Bank of the US Dipl.- Kfm. Thomas Stiegler, University of Göttingen

9. Balance of payments. – Global imbalances Recieving foreign currency – a basic financial transaction (2) so a one Dollar bill means that the FED owes the bearer of the note the purchasing power of one Dollar. as the Dollar is MONEY in the US, everybody there can use it and use this promise to exchange this bill into goods in any shop If an American thus pays a Russian firm a Dollar bill, the economy of the US (namely the FED) now owes Russia GOODS in the purchasing value of one Dollar. (basic financial transaction) Dipl.- Kfm. Thomas Stiegler, University of Göttingen

10. Balance of payments. – Global imbalances Recieving foreign currency – a basic financial transaction (3) so a non intuitive situation occurs: if we accept a dollar bill as payment for exported goods, the US will be in debt with our firm, and thus with Russia. In TAKING a Dollar bill TO Russia, we EXPORTED capital! We used capital to produce this product and now accept a promise of payment. As long as we don’t get the value of the goods back, we give a loan to the US and thus export our capital (we can use these Dollars in investments) Dipl.- Kfm. Thomas Stiegler, University of Göttingen

11. Balance of payments. – Global imbalances ImbalancesoftheCurrentAccount the current account is in deficit, when the sum of trade balance, services account and balance of factor incomes is below zero. any partial balance can cause a deficit or a surplus, even if two partial balances are in surplus, the overall balance can be in deficit. (trivial) Let’s have a look at the determinants! Dipl.- Kfm. Thomas Stiegler, University of Göttingen

12. Balance of payments. – Global imbalances Balance offactorincomes Looking at the balance of factor incomes we can concentrate on the income of the factor capital. The income of workers from abroad is marginal in dimension. If there is income from the factor capital which conclusion about earlier current accounts can be made? Only if we exported capital, we can receive returns on investment from abroad. As we saw above, we export capital exactly then, when we export goods or services. So we can conclude: we had surpluses in current account in the past. Dipl.- Kfm. Thomas Stiegler, University of Göttingen

13. Balance of payments. – Global imbalances It‘s not unimportant! Howeverweexclude it. we can thus conclude: The balance of factor incomes depends on trade and services balances of the past. (as well as the given yield on our investments.) Knowing that and searching for reasons of imbalances in the current account when can then exclude the balance of factor income as an dynamic factor. However this factor can be large in extend. We’ll focus on its origin: trade and services balances.(assumption: balance of factor income = 0) Dipl.- Kfm. Thomas Stiegler, University of Göttingen

14. Balance of payments. – Global imbalances Determinants of trade and services balances If the absorption of goods and services in a country is bigger than its production, the current account is in deficit. we know the classical equation Investment = Savings for a balanced good’s marked in a closed economy. For buying goods abroad, we need money. If buying from abroad, the savings will decline, as we spend money there. Leading to a new equation: Savings = Investment – Current Account (S = I – CA) Dipl.- Kfm. Thomas Stiegler, University of Göttingen

15. Balance of payments. – Global imbalances Determinantsofthe CA if in deficit S = I +CA mirrors as well the capital balance: As the domestic savings are smaller than the demand for investments, we need to import capital. So the two variables domestic savings and investment are the real economic main determinants of the current account balance. Dipl.- Kfm. Thomas Stiegler, University of Göttingen

16. Balance of payments. – Global imbalances Savingsandthecurrentaccount why are the savings going up, once I have a CA in surplus? remember: I get paid in Dollar, but can’t spend them! I bring goods abroad and the foreigners are in dept with me If doing so I can’t use the goods on my own, disclaim on consume  I save. Dipl.- Kfm. Thomas Stiegler, University of Göttingen

17. Balance of payments. – Global imbalances Capital account. – typesoftransactions As said above, there are different types of transactions in the capital account. Through the balance of factor incomes they have relevance for the current account as well. We assume, that the basic transaction shown above is of minor importance, as the opportunity costs of keeping foreign currency in cash are to high. Even Central Banks will only keep cash as reserves in very limited extend Dipl.- Kfm. Thomas Stiegler, University of Göttingen

18. Balance of payments. – Global imbalances Foreigndirectinvestments (FDI) FDI are investments to gain operative influence on an existing firm or to found a new branch of foreign firm (greenfield investment) FDI are usually long run investments Profits are partially reinvested, the rest flows abroad FDI can help less developed countries to develop (spill over effects) In times of crisis they stabilize the situation Dipl.- Kfm. Thomas Stiegler, University of Göttingen

19. Balance of payments. – Global imbalances Foreigncredits foreign credits are often of medium term duration as no sunk costs for building up a firm appear, they can be retracted far easier than FDI and are thus of more risk for the receiving country due to insurances against currency fluctuations, the interest rates can be quite high in times of crisis they destabilize situation (will be retracted) Dipl.- Kfm. Thomas Stiegler, University of Göttingen

20. Balance of payments. – Global imbalances Portfolio investments Portfolio investments can be strategic long term participations in a firm or short term investments for speculation. Dividend payments flow abroad Can be retracted easily In times of crisis can destabilize situation, but help stabilizing situation afterwards, as chance of buying shares of healthy companies for low prices will be used Dipl.- Kfm. Thomas Stiegler, University of Göttingen

21. Balance of payments. – Global imbalances Monetaryreserves Currency reserves of the Central Bank appear once an exporting firm exchanges its foreign currency in local currency. Thus they are consequence of CA surpluses. Currency reserves are usually not held in cash but in conservative investments, being easily realizable By using currency reserves Central Banks can try to avoid crisis Dipl.- Kfm. Thomas Stiegler, University of Göttingen

22. Balance of payments. – Global imbalances Example USA The savings quota in the US is usually very low. If not taking companies treasured gainings into account even below zero sometimes! Meaning: private Americans spend more money for consummation than they earn. (unique situation in the world) This high demand for consummation leads to a high demand for imports. Taking CA into deficit Dipl.- Kfm. Thomas Stiegler, University of Göttingen

23. Balance of payments. – Global imbalances USA – Savingsas a shareof GDP Source: www.worldbank.org Dipl.- Kfm. Thomas Stiegler, University of Göttingen

24. Balance of payments. – Global imbalances USA – CurrentAccountas a shareof GDP Source: www.worldbank.org Dipl.- Kfm. Thomas Stiegler, University of Göttingen

25. Balance of payments. – Global imbalances Analysis we clearly see, that the described situation leads to long term CA deficits of the USA this means, the debt of the US economy is growing strong over the time, leading to a situation, where many US firms are owned by foreigners. Biggest shareholder: Chinese state funds! The situation can become then critical, once foreigners are not willing anymore, to accept US Dollars as payment, or are not interested anymore in investments in the US in fright of the non sustainable situation Dipl.- Kfm. Thomas Stiegler, University of Göttingen

26. Balance of payments. – Global imbalances Everlastingsurplus – a gain? But is the “German way” the better one? besides 1990-2001 (in consequence of the German reunification) Germany always has vast CA surpluses. This means Germans are disclaiming on vast amount of what they are producing with their work and capital The national wealth thus is at a lower level it could be Danger of loosing foreign assets, in crisis dependent on foreign economy, as domestic demand underdeveloped Dipl.- Kfm. Thomas Stiegler, University of Göttingen

27. Balance of payments. – Global imbalances Way out? Foreign assets gained through exports should be used profitable and reduced again to spread the wealth in the country of its origin. In bad times of business cycle exports should stabilize local production, in boom times imports should take place. Over the time, the CA should be balanced. In this respect France seems to do a rather good job. Dipl.- Kfm. Thomas Stiegler, University of Göttingen

28. Balance of payments. – Global imbalances US paradox. Balance offactorincomes One would expect to have the US big deficits in the balance of factor incomes, as they seem to have everlasting CA deficits. In fact they have had SURPLUSES till the beginning of the actual crisis. So is the theory I talked about all the time just wrong? What could be the reason for that? Dipl.- Kfm. Thomas Stiegler, University of Göttingen

29. Balance of payments. – Global imbalances US paradox. Reasons (1). Reason one: the US Dollar. still leading currency in the world, so MAIN RESERVE currency of Central Banks  as said before, these are investing money very conservative often in US state bonds. Huge amounts of Dollars are in reserves in China, Russia, Japan. Absorbing the foreign debt at large scale but at low return payments to foreign investors The role of the US Dollar as No.1 currency reserve currency leads to a situation, in which the return on invested capital in the US is low, due to the large amount of Central Banks’ conservative investments. Dipl.- Kfm. Thomas Stiegler, University of Göttingen

30. Balance of payments. – Global imbalances US paradox. Reasons. (2) Reason two: structure of US economy The US economy is dominated by huge scale companies. These companies are easily able to invest in expensive and highly lucrative projects There are values of world brands like “Coca Cola”, “Microsoft”, “Apple” etc. By exporting the “good” name the payback increases. Almost all the savings and thus the money available for foreign investment is on the site of companies (priv. savings near 0), which increases the efficency. The structure of the US foreign investments leads to an effective investment with high returns on investment. Dipl.- Kfm. Thomas Stiegler, University of Göttingen

31. Balance of payments. – Global imbalances US paradox. conclusion to sum it up, we have a situation in which there is low return of investment on average on capital invested in the US, and high roi on US capital abroad So even if LESS US capital invested abroad the returns are in total higher, than of the capital invested in the US The US are the only economy with this inverse structure. However it gets less and less, as dept goes up. Although the return on investment rate keeps higher. Dipl.- Kfm. Thomas Stiegler, University of Göttingen